Tuesday, 30 April 2013

Even if all projects were to get clearances tomorrow, we may see actual activity in less than half

The Prime Minister's Economic Advisory Council (PMEAC) report suggests that higher GDP growth next year is achievable if government policies and administrative actions support investment. Primarily, if the government clears stalled projects, and environment and other clearance are given for projects through the Cabinet Committee on Investments (CCI), Indian GDP growth can rise to 6.7% next year.

The problem of stalled projects has seen some progress in recent weeks as the CCI gave clearances to oil and gas projects. The mandate of the CCI is to give clearances to large projects. While this is a step in the right direction, and would lift investment and growth even if only a few large projects get kick-started, there are additional difficulties that would need to be addressed before growth can pick up to 6.7% next year.

First, some of the projects that are stalled today were bid before the 2008 crisis. Remember the pre-crisis years? Growth in India was in double digits, the world economy was booming and almost every investment project looked attractive. The pegging of the rupee to the dollar led to a high growth of forex reserves and consequently bank credit. Some of the bids by the private sector were quite aggressive based on its over-optimism. In today's far more sober environment, it is not clear that even if given clearances, all of those projects would be attractive. At least a third of them might appear to be unattractive.

Second, the projects that are stuck in mid-way for many years have had financial implications for the balance sheets of the companies and banks involved. Long delays in completion of projects has meant that companies have not been able to pay back loans taken for the projects. Banks that had given loans have seen these loans get into trouble. Many banks are reluctant to call these non-performing loans. Many loans have been re-structured. RBI data shows that the growth of restructured advances has been much faster than credit growth of banks. Between March 2009 and March 2012, while total gross advances of the banking system grew at a growth rate of less than 20%, restructured standard advances grew by over 40%. Public sector banks account for a disproportionately large part of this. Restructured accounts have grown at a rate of 47.86% in public sector banks as against a growth rate of credit of 19.57%. Loans to industry, especially large industry, have seen the most restructuring. Public sector banks, especially after the recent corruption scandals, may be reluctant to lend to companies in distress even when they can.

The above suggests that even if a project bid by a large company obtains a clearance, the company may no longer be in a position to undertake fresh borrowing to undertake the project. Or banks may no longer lend to it for new projects beyond the lending they are doing to recover old loans. This may account for another one third of the stalled projects not being revived even if given clearances.

Further, the terms of restructuring loans to companies in distress usually assume that in a couple of years the economy will recover and the company will be able to pay back the loan. Figure 1 shows the sharp decline in GDP growth, down to 4.5% in the quarter ending December 2012 as one of the sharpest downswings in growth in recent years. The seasonally-adjusted quarter-on-quarter growth was 3.5%.

Nor have we seen investment pick up. Figure 2 shows the seasonally-adjusted quarter-on-quarter growth of investment by the private corporate sector. It was 0% in the January to December quarter. When investment is 0% and GDP growth is 3.5%, it will take a strong change in the business environment and sentiment for them to pick up.

Figure 3 shows that those signs of change in business perceptions are not to be seen yet. It shows new project announcements per quarter by all sectors and all categories of investors. Project announcements as a share of GDP have been declining quite steadily since 2010. When sentiments improve, this is the first place where we expect to see the optimism. Even if projects are not finally implemented, they must at least be announced for the investment to kick off.

What we might see in the next few months may be a pick up due to some projects being revived. Once investment activity starts, it may induce optimism. Yet one must be aware that even if all projects were to get clearances tomorrow, we may see actual activity in less than half. We will be fortunate if growth does not fall below that of the 5% we appear to have achieved in 2012-13.

Its tilt to consumption-led growth is good news for India and the global economy

Unlike in India, the slowdown in Chinese growth appears to be not merely a cyclical downturn, but lower trend growth rate that Chinese policymakers see as desirable. It forms part of China's strategy to rebalance the domestic macroeconomy towards a slower growth rate of employment, lower investment and higher consumption. This is good news for global rebalancing as China's exchange rate policy should now become more flexible, Chinese current account surpluses should come down and accumulation of Chinese forex reserves should slow down or stop. For India, a relatively more consumption-oriented China could mean higher exports, both to China and the rest of the world, lower commodity prices and less of a pressure from exporters for exchange rate intervention.

After growth at double digits for many years, China grew at a much slower 7.7 per cent in the first quarter of the year. At a recent conference in Beijing, I heard Chinese policymakers sounding fairly comfortable with this lower growth. Indeed, they argued lower growth in China was desirable. It almost seemed that it was planned.

The main arguments in favour of lower growth - an average of 8 per cent in the next 10 years and 7 per cent thereafter - was mainly China's demographics. As the Chinese working-age population starts shrinking due to the replacement of the current working population by those born after the one-child policy was put in place, there is less need for high job growth. The last few decades were ones in which China was trying to meet two objectives: earn foreign exchange and create jobs. The high growth rate of job creation was necessary to absorb the large number of people joining the labour force. If the same growth rate continues, China will have labour shortages. With a slower growth of the working population and labour force, wage growth rather than employment growth will be the focus.

Second, China has undertaken significant infrastructure investment in recent decades. In coastal areas, China has met its targets for infrastructure investment. It now needs to utilise better the infrastructure that it has created. Some estimates even show that China's infrastructure investment has been excessive. The need for additional investment in infrastructure is lower, and so the investment strategy will be modified accordingly.

A shift towards domestic consumption-led growth will make the Chinese growth model less dependent on exports. In episodes of global slowdown like the recent one, the Chinese economy can then continue to grow more steadily. The decline in the Chinese trade surplus and slower exports after the crisis have made it evident that, even if desirable, the policy of export-led growth was unlikely to be sustainable.

At the recent IMF-World Bank meetings in Washington DC, China has indicated that it will allow the renminbi to move in a wider band than it has hitherto. This effectively means that it will allow the yuan to appreciate. This will make Chinese exports more expensive and imports into China cheaper. Such an exchange rate regime will be more suitable for a domestic consumption-led, rather than an export-led growth strategy.

An appreciation of the yuan will also allow other emerging economies to permit their currencies to be more flexible. Today when China sustains a policy of an undervalued exchange rate through its intervention and sterilisation, other central banks often come under pressure to do the same. The context in which China has been able to financially repress the system and pay low or negative real interest rates to households is unlikely to work in more market-oriented and democratic countries. It will be a relief for other EM (emerging market) central bankers not to have the kind of pressure they face thanks to China today.

One of the origins of the global crisis was diagnosed to be the cheap funding available in the US economy owing to Chinese purchase of US treasury bills. The high level of liquidity, asset price bubbles and, finally, the meltdown were said to be caused by the Chinese policy of keeping consumption low, savings high and then pushing those savings into the US, where households consumed too much and did not save. This arrangement was facilitated by the Chinese exchange rate policy. A change in the Chinese policy is expected to lead to a global rebalancing.

For India, which has had an economy much more based on domestic consumption, where the domestic savings to GDP ratio is closer to 30 per cent, in contrast to China's 50 per cent, a rebalancing in China is good news. Not only is a more rebalanced world a better and more sustainable business environment, with less vulnerable risks, but India could gain directly as it is often seen as a competitor to China. In areas where India can compete with Chinese products for a share of the market, its exports can benefit. In addition, if India is able to enter the market in certain products, it stands to gain. As China focuses more on growth in services, as it has seen recently, as well as high-end products, away from the low-end manufacturing that dominated its growth model, Indian exports stand a better chance.

Lower investment in China is likely to lead to a softening of global commodity prices. As a large commodity importer, India stands to benefit from softer prices. Though it may be argued that global growth may slow down if China slows down, as the Chinese policymakers argue, if the growth can be higher quality growth, protecting the environment and reducing pollution, with higher wage growth, more innovation and less distortions, the world stands to gain.

Economic stability is not the only issue at stake. Political stability in China is a challenge as inequality has grown. If China does not follow a wider consumption-based growth model, the bigger challenge may be political rather than economic stability. It seems that the Chinese government has set the forces for domestic rebalancing in place, it remains to be seen how successful the policy will be.

Thursday, 11 April 2013

Consumer protection should be at the heart of the financial regulatory framework

Does India need a new law for consumer protection in finance? One lesson from the global financial crisis is that unsuitable housing loans sold to poor, uneducated consumers could pull down the world's financial system. Very few people would have believed that sub-prime loans, which constituted a very small part of housing loans and that too only in one country, could trigger a crisis that led to banks failing, money markets crashing, governments falling, countries going bankrupt, millions becoming unemployed and the GDP of many nations going down. This is not to argue that the sale of unsuitable housing loans was the only regulatory failure that led to the global crisis, but an important lesson is that a regulatory system that does not prevent the sale of unsuitable financial products to consumers could be putting the financial system and the entire economy at risk. Not only is consumer protection an important end in itself, if it lies at the heart of financial regulation, bad practices that result in the failure of firms and markets can be checked.

Today in India, there is very little reference to consumer protection in primary legislation in the financial sector. Not surprisingly, none of the financial laws on which regulation is based, and which were written long before there was clear thinking about the need for consumer protection, provides consumers with basic rights or protections. Nor do they give regulators a specific set of relevant powers to pursue the objective of consumer protection. It is not treated as a core pillar of financial regulation. Many countries are rewriting laws to bring this perspective into financial sector regulation.

Some regulators have issued regulations based on the general rule-making powers given to them in their respective laws. For example, SEBI issued Disclosure and Investor Protection Guidelines in 2000. Various guidelines have been issued by the RBI and IRDA to protect consumers in banking and insurance. However, consumer protection regulation remains weak and varies across different sectors and services.

The approach adopted by the Financial Sector Legislative Reforms Commission (FSLRC) is that consumer protection needs to be treated as a core part of the legal and regulatory framework. So the first step towards ensuring consumer protection is to have good primary legislation that provides for it and makes it a priority for regulators, empowering them adequately. The primary law should require all regulators to formulate regulations that ensure consumers are protected from unfair practices. If, in a contract, there is a term that permits one party (often the financial firm) but not the other party (often the customer) to avoid or limit the performance of the contract, or to vary the terms of the contract or the services provided, the contract is unfair. If the conduct of the financial service provider, who often has greater market power, is misleading or abusive or coercive, such conduct is unfair.

Similarly, consumers should have a right to financial privacy, data ownership and data security. The laws were written before it was easy for an employee to sell a CD containing the digital records of his firm's customers for a small price. So the laws, unsurprisingly, were not geared to handle this eventuality. Today, we can argue that consumers should have the legal right to own their financial data. Consumers dealing with financial institutions must have the right to expect that their financial activities will have a reasonable amount of privacy. They must have the assurance that the data is secure.

Additional rights and protection need to be given to retail customers, who may be individuals or businesses, carrying out small value transactions. They are often at an even bigger disadvantage. Retail consumers should not be sold unsuitable products. The suitability of a financial service or product depends on the profile and needs of the specific consumer. The lack of knowledge often makes it difficult for the consumer to decide what will work best for her. The law should make it a right for the consumer to be given sufficient time, relevant information and, if possible, sound advice to help her decide on the suitability of the financial product she is buying.

For example, if a consumer is considering buying life insurance, in most cases, simple information disclosure is inadequate. There should be an assessment of the consumer's need. Proper advice would be necessary to ensure that the consumer purchases the right kind of insurance, with the optimal level of coverage. For certain services, the regulator may mandate advice. Providers of such services would then not be allowed to approach the potential consumer without some kind of a basic process of needs assessment and advice. For example, regulations could mandate that before a financial institution makes a recommendation to a consumer regarding a specific financial service, it gathers sufficient information from the customer to ensure that the service is likely to meet her needs and capacity.

Under the draft Indian Financial Code (IFC), advice would typically be accompanied by increased responsibility for the financial service provider, making it accountable for consumer outcomes, leading up to compensation for consumers if they have been poorly advised. Most services should come with a high level of responsibility for the providers, especially if the providers approach the consumer.

Consumers should also be given reasonable time to take the decision. For example, consumers going in for certain financial services with long-term implications could be allowed a cooling-off period, during which they may cancel the contract or decide not to enter it.

Consumer protection regulation is ineffective if consumers do not have an effective ex-post grievance redressal mechanism. At present, this is highly inadequate and varies across sectors. The draft IFC proposes to set up a fast and efficient non-sectoral, widely accessible consumer redressal mechanism.

It seems fairly obvious that consumers should have protection against unfair conduct and terms. But we need to put that in the law, because unless it says so, regulators cannot write regulations that ensure such protection or penalise firms that violate these principles. The draft IFC proposes to enshrine these principles in law.